Mernda Developments Pty Ltd (in liq) v Alamanda Property Investments No 2 Pty Ltd
[2011] VSCA 392
•30 November 2011
SUPREME COURT OF VICTORIA
COURT OF APPEAL
S APCI 2010 0055
| MERNDA DEVELOPMENTS PTY LTD (in liq) (ACN 101 396 883) | |
| First Appellant | |
| and | |
| GIUSEPPE MICHELLE RAMBALDI (in his capacity as liquidator of Mernda Developments Pty Ltd (in liq) ACN 101 396 883) | Second Appellant |
| v. | |
| ALAMANDA PROPERTY INVESTMENTS NO 2 PTY LTD (FORMERLY KNOWN AS DOLLARFORCE FINANCIAL SERVICES PTY LTD (in liq) (ACN 006 574 796) | First Respondent |
| and | |
| CLESTUS WEERAPPAH | Second Respondent |
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JUDGES: | Warren CJ, Mandie JA, Judd AJA |
WHERE HELD: | MELBOURNE |
DATE OF HEARING: | 20 October 2011 |
DATE OF JUDGMENT: | 30 November 2011 |
MEDIUM NEUTRAL CITATION: | [2011] VSCA 392 |
JUDGMENT APPEALED FROM: | Mernda Developments Pty Ltd (in liq) & Anor v Alamanda Property Investments No 2 Pty Ltd & Anor [2010] VSC 132 |
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CORPORATIONS – Whether breach of duty under ss 181 and 182 of the Corporations Act 2001 (Cth) – Whether transaction in best interests of the company – Group of companies –Whether compensation payable under s 1317H(1) of the Corporations Act 2001 – Appeal allowed
PROCEDURE – Whether further grant of leave to proceed under s 500(2) of the Corporations Act 2001 (Cth) necessary to prosecute appeal – Leave to proceed granted
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| APPEARANCES: | Counsel | Solicitors |
| For the Appellants | Mr L Glick SC with Mr S Maiden | Schetzer Brott & Appel |
| For the Respondents | No appearance |
WARREN CJ
MANDIE JA
JUDD AJA:
The central issue in this appeal is whether the second respondent, Clestus Weerappah, a shadow director of the first appellant, Mernda Developments Pty Ltd (in liq), breached his duty under s 181(1)(a) of the Corporations Act 2001 (Cth) by procuring Mernda, as a borrower, to enter into a facility agreement on 15 May 2003 with the first respondent as lender, and to grant a charge over all the assets in favour of the first respondent shortly thereafter. Having found that Mr Weerappah was a shadow director, the trial judge was not satisfied that he had breached any of his duties by procuring Mernda to enter into the agreement or give the charge.
The first respondent, Alamanda Property Investments No 2 Pty Ltd (in liq) was formerly known as Dollarforce Financial Services Pty Ltd. The appellants seek a declaration that the facility agreement and the charge be declared void as against Mernda; an order that Alamanda pay to Mernda the amount paid by Mernda to Alamanda on 19 December 2003 pursuant to the facility agreement and charge, less the amount of Alamanda’s advances to Mernda; alternatively, compensation under s 1317HA of the Act; and an order that Mr Weerappah pay compensation to Mernda pursuant to s 1317HA of the Act. The amount of the payment made by Mernda to Alamanda on 19 December 2003 was $9,574,289.46.
At the time Mernda entered into the facility agreement it was indebted to Alamanda in the sum of $1,030,516. There were 24 other borrowers. Twenty four of the borrowers, including Mernda, were indebted to Alamanda in varying amounts. The recitals record that the lender had agreed, at the request of the borrowers (and each guarantor), to provide a loan facility to the borrowers. The principal amount of the loan was not to exceed $15 million.
The borrowers under the agreement, including Mernda, were special purpose entities incorporated to acquire, develop and sell a single property as part of a ‘joint venture’ between Dale Howard Robertson and Mr Weerappah. Mr Robertson’s role was to seek out development opportunities, while Mr Weerappah provided the necessary funding to acquire and develop the properties. There was no formal agreement between the two men except that reflected in the shareholdings they controlled in each development company.
The arrangement between the two men to acquire, develop and sell each property through a separate corporate entity was a deliberate strategy to avoid ‘cross-collateralisation’. That was a euphemism to describe the risk that one project might adversely impact on another or others. The object of employing separate entities for each project was to quarantine the risk. After a project had been completed and the property sold, the company had served its purpose and, in the words of Mr Robertson, ‘we were able to close that company down’.
The arrangements between the two men also included a deliberate strategy to ensure that Mr Weerappah could not be identified as a director or officer of any of the development entities, notwithstanding his crucial role as financier and as an important decision-maker for the companies. Mr Robertson was the appointed director of the development companies, including Mernda. He acted under the direction of Mr Weerappah in relation to all important decisions. For example, Mr Weerappah instructed Mr Robertson to execute the facility agreement on behalf of all but one of the borrowers. The trial judge found that Mr Weerappah was to be regarded as a director of Mernda and that Mernda’s entry into the facility agreement was a requirement of Mr Weerappah. These findings were not challenged, and are supported by the evidence. The trial judge proceeded on the footing that, as a shadow director, Mr Weerappah caused Mernda to enter into the facility agreement, give the charge and to make payment under the facility agreement on 19 December 2003.
The facility agreement contained a schedule, recording the debt due by each borrower to Alamanda. The amount due by Mernda was substantially referable to the deposit paid on its behalf for the purchase of land at 1410 Plenty Road, Mernda at a price of $8,500,000 plus GST. The contract of sale required Mernda to pay a deposit of $1 million by 14 October 2002, a further $850,000 by 1 September 2003 and the balance by 1 September 2004. The amount of the indebtedness of each borrower as at 15 May 2003 is set out below.
699 Burke Road Pty Ltd
$396,307.00
Annesley Commercial Pty Ltd
$0.00
Annesley Fuel Pty Ltd
$93,832.00
Chaucers Canterbury Pty Ltd
$1,996,786.00
Dandenong Road Pty Ltd
$172,982.00
Doncaster Apartments Pty Ltd
$2,352,247.00
Greydae Pty Ltd
$200,000.00
Jersey Street Pty Ltd
$597,236.00
Lorimer Street Pty Ltd
$210,663.00
Mernda Developments Pty Ltd
$1,030,516.00
Packington Street
$411,001.00
Plentie Pty Ltd
$68,037.00
Kiernan Ave Pty Ltd
$0.00
Kalinda Group Pty Ltd
$137,233.00
Wanda Street Mulgrave Pty Ltd
$1,050.00
St Georges Road Northcote Pty Ltd
$1,050.00
Heatherton Road Dandenong North Pty Ltd
$2,150.00
Centre Road East Bentleigh Pty Ltd
$1,750.00
Boronia Road Boronia West Pty Ltd
$1,050.00
Warrandyte Road Ringwood North Pty Ltd
$11,860.00
Schools of the Future Pty Ltd
$9,000.00
Vitalis Corp Pty Ltd
$39,400.00
Doncaster Commercial Pty Ltd
$39,600.00
My Building No 1 Pty Ltd
$729,438.00
Vitalis Group Pty Ltd
$2,668,453.00
Total
$11,171,641.00
Total less Mernda’s borrowings
$10,141,125.00
Mr Robertson said that at the time Mernda entered into the facility agreement, it had no immediate need for further funding; but that it would require funding to meet the instalment of $850,000 due on 1 September 2003, and the balance of the purchase price on 1 September 2004.
The only asset held by Mernda was the contract to purchase the land and any value added by development work undertaken. Mr Robertson said that this was common to all of the development entities. While the scope of the development activities differed from project to project, there was a common objective, namely, to improve the value of the land and make a profit on resale.
Shortly prior to the execution of the facility agreement, the relationship between Mr Robertson and Mr Weerappah began to deteriorate. They had apparently contracted to purchase a reception centre in Canterbury known as Chaucers. The transaction fell through because of their failure to meet a settlement obligation and, as Mr Robertson put it, ‘I suppose Mr Weerappah lost a bit of confidence in my ability’.
The facility agreement, dated 15 May 2003, was prepared by Russell Kennedy, solicitors for Alamanda. Recital A provides:
The Lender has agreed, at the request of the Borrowers and of each Guarantor to provide a loan facility to the Borrowers, the principal amount of which is not to exceed $15 million.
There were 25 ‘Borrowers’ including, of course, Mernda. The ‘Guarantors’ were Mr Robertson and his company Rumasc Pty Ltd, and every person who from time to time was or became a director or shareholder of a borrower. The ‘Loan’ was defined to mean the loan of the Principal by the Lender (Alamanda) to the Borrowers on the terms set out in the agreement. The ‘Principal’ was defined to mean, at any time and from time to time, the amount of the Loan provided under the agreement by the Lender to or at the direction of the Borrowers or any one or more of them. Clauses 2 and parts of cl 3 are important. We set out the relevant parts in full.
2 LOAN
2.1The Lender agrees to lend to the Borrowers and the Borrowers agree to borrow the Principal on the terms and conditions set out in this agreement.
2.2The Loan:
2.2.1has been made as at the date of this agreement by the Lender providing financial accommodation to the Borrowers in the approximate amounts set out in Schedule 1;
2.2.2may be made by the Lender granting further financial accommodation to one or more of the Borrowers at their written request, but the Principal outstanding at any time is not to exceed $15,000,000.00.
2.3Notwithstanding clause 2.2.1, and without limiting clause 21.7, each Borrower is responsible jointly and severally to the Lender for the whole of the Principal and the Interest and other amounts payable to the Lender pursuant to this agreement.
3 BORROWER’S OBLIGATIONS
3.1 Repayment of Principal
3.1.1 The Principal must be repaid in an amount equal to:
(a)any proceeds realised by any Borrower from the sale or disposal of any real property or any interest in real property which is listed in Schedule 2;
(b)any proceeds realised by any Borrower from the issue of any shares or interests in shares of the Borrower or by any Guarantor from the sale or disposal of any shares in any Borrower,
Less:
(c)amounts required and actually applied to discharge any registered mortgage over real property which is sold or disposed or in which an interest is sold or disposed (other than a registered mortgage held by any Borrower, or any director of or shareholder in a Borrower); and
(d)any other costs and expenses of the issue, sale or disposal which are approved of in writing by the Lender.
3.1.2The recipient of proceeds referred to in clause 3.1.1 must:
(a)arrange for that part of the proceeds equal to the amount of Principal which must be repaid to the lender to be paid directly to the Lender; or
(b)make such other arrangements with the Lender as the Lender may approve for such repayment.
3.1.3The Principal then outstanding, together with any other amounts unpaid under this agreement, must be repaid in full on 31 December 2003.[1]
[1]Emphasis added.
Clause 3.4 required the provision of securities. They were the guarantees, registered fixed and floating charges over all assets of each borrower, and a registered mortgage in favour of the lender over the real estate owned by each borrower. In the case of Mernda, its interest under the contract to purchase the land was the subject of the charge. It was not yet the registered proprietor of the land.
On 31 October 2003, Mernda contracted to sell the land to Summit Investment Group Pty Ltd for $15,500,000 ‘plus GST’. A deposit of $1,550,000 was paid with the balance due on 19 December 2003 or earlier by agreement. Settlement took place on 19 December 2003, simultaneously with settlement of the purchase by Mernda. On payment of the balance of the purchase price there was a net amount due to Mernda, after stamp duty, commission, other disbursements and expenses, of $9,574,289.46. That amount included Goods and Services Tax collected by Mernda from Summit Investments in the sum of $1,550,165.26. Thus, Mernda had earned a gross profit of $7 million from the transaction, before adjustments and expenses.
On the day before settlement, Russell Kennedy wrote to Donald Davidson, solicitor for Mernda, reminding him of Mernda’s obligation under the facility agreement to pay to the lender (Alamanda) ‘all proceeds from the sale of the land to be applied in repayment of amounts outstanding under the facility agreement’. Russell Kennedy were to attend settlement, and sought confirmation that it would receive a bank cheque for the whole of the proceeds less purchase moneys and actual expenses. By that time, the actual indebtedness of Mernda to Alamanda had increased to approximately $1,850,000 following payment of the instalment due by 1 September 2003.
At the settlement on 19 December 2003 Mernda paid the whole of the net proceeds, in the sum of $9,574,289.46, to Russell Kennedy. As a consequence, Mernda was left without any assets. In the events that occurred the Commissioner of Taxation sought recovery of unpaid tax in an amount exceeding $1.6 million, which was presumably the amount collected for GST, together with interest. As at the commencement of the trial, the claim by the Commissioner of Taxation exceeded $3.6 million. The transactions that took place on 19 December 2003 were a central feature of the statement of claim and the appellants’ case at trial. The transactions were compendiously described in the statement of claim as the ‘Alamanda Acquisition’. We will refer to the transactions as the ‘settlement transaction’.
The proceeding was commenced by the appellants on 6 September 2007. The appellants were plaintiffs and the respondents were defendants. At that time Alamanda was not in liquidation. On 8 December 2008 Alamanda entered into a creditors’ voluntary liquidation.
The appellants pleaded an elaborate case against the respondents, claiming that the facility agreement and the charge were void ab initio; an injunction compelling Alamanda to release Mernda from the charge; a declaration that Mr Weerappah contravened s 588G(2) of the Act by failing to prevent Mernda from incurring a debt due to the Commonwealth for GST in the sum of $1,550,165.26; an order that Alamanda pay $9,574,289.46 to Mernda; and as against both respondents, payment of the sum of $9,324,289.46; interest and costs.
The structure of the appellant’s case as pleaded was first to contend that Alamanda had been unjustly enriched by the amount of the GST which they alleged was paid by Mernda under a mistake of law. The appellants alleged that Mernda paid the amount under the mistaken belief that Alamanda was entitled to be paid the GST amount under the facility agreement. Next, the appellants alleged that Mr Weerappah caused, procured or allowed Mernda to trade while insolvent, by failing to prevent it from participating in the settlement transaction, presumably to the extent that Mernda paid all of its money to Alamanda. The liquidator claimed to be entitled to recover from Mr Weerappah an amount equal to the amount paid to Alamanda at the time of the settlement transaction, alternatively the GST amount. The basis of that claim was insolvent trading. Finally, the appellants alleged that Mr Weerappah had breached his duties as a director of Mernda. This cause of action depended upon the appellants establishing that Mr Weerappah was a shadow director of Mernda.
A substantial part of the appellants’ case at trial was to establish that Mr Weerappah was a shadow director. The appellants alleged that Mr Weerappah breached his duties as a director by causing or procuring Mernda to execute the facility agreement and charge, and to pay the net proceeds from the settlement transaction to Alamanda. By reference to the scope of the obligations attributed to Mr Weerappah and the particulars of breach, the appellants alleged a breach of his duty to act in good faith and in the best interests of Mernda (s 181(1)(a)); that he improperly used his position to gain an advantage for himself or someone else, presumably Alamanda (s 182(1)(a)); and that he improperly used his position to cause detriment to Mernda (s 182(1)(b)).
The appellants’ case in a nutshell was that Mernda derived no benefit by entering into the facility agreement and giving the charge, but incurred a substantial liability which was called in on 19 December 2003. Thus, the appellants argued, the decision by Mr Weerappah to procure Mernda to enter into the facility agreement and give the charge was not in the best interests of Mernda. They argued that Mr Weerappah acted improperly by causing Mernda to become insolvent.
The appellants’ breach of duty case at trial, for breach by Mr Weerappah of his duty to act in the best interests of Mernda when procuring Mernda to enter into the facility agreement and give the charge, relied substantially upon the effect of the facility agreement to immediately make Mernda liable for and to secure the debts of other borrowers in which Mernda had no interest at all. Those other debts amounted to $10,141,125. They argued that Mernda had no right to further funding which was, in any event, capped at $15,000,000. At the date of the agreement only $3,828,359 was available under the facility agreement if further advances were approved. Mernda’s requirements exceeded that amount. The appellants drew attention to the fact that under the facility agreement, Alamanda was under no obligation to make any further advances. They argued that Mernda had no interest in supporting the other 24 borrowers; and that the nature of the business carried on by the other borrowers, and the business arrangement between Messrs Weerappah and Robertson, were such that each entity was to be quarantined from the affairs of the other. Accordingly, they argued that it was not in the interest of Mernda to enter into the facility agreement and give the charge, and that Mr Weerappah had breached its duty to Mernda by procuring it to do so.
The appellants’ case at trial was complicated by claims made to recover the amount of the GST collected by Mernda and paid to Alamanda. They contended that the liquidator was entitled to recover that amount, in the sum of $1,550,165.26, on the basis that it was not payable under the facility agreement, or that the payment was made in contravention of s 588G(2) of the Act, as an uncommercial transaction. They reasoned that the payment of the net proceeds to Alamanda made Mernda insolvent and unable to discharge its obligation to the Commonwealth of Australia.
The trial before the learned trial judge presented real difficulties. The respondents did not attend and were not represented. His Honour did not have the usual assistance of counsel for the contradictor in an adversarial proceeding. Nor were the respondents represented on the appeal. When reinstating the appeal on 9 August 2010, the court noted that the first respondent did not propose to participate in the appeal, and that documents sent to Mr Weerappah at his address for service had been returned. The court ordered that the appellants and the first respondent were only required to serve Mr Weerappah upon receipt of a written request. The order noted that the court registry had forwarded a copy of the order to Mr Weerappah.
Having considered the question of Mr Weerappah’s position as a shadow director and, with respect, correctly found that he was, the trial judge moved to what he described as the more difficult question – whether there was a breach of duty by Mr Weerappah by procuring Mernda to enter into the facility agreement, by procuring Mernda to give the charge and by his involvement in the payment of the net proceeds from the settlement transaction to Russell Kennedy.
His Honour approached his analysis by reference to the nature of the relationship between Mernda, the other borrowers and Alamanda. He characterised the parties to the facility agreement as a group in which the borrowers had an interest in supporting one another and the lender. The appellants argued that in so doing his Honour fell into error. His Honour’s approach to the question of breach, while not expressly so confined, seemed to focus on the duty imposed under s 181(1)(a) of the Act which provides,
(1)A director or other officer of a corporation must exercise their powers and discharge their duties:
(a)in good faith in the best interests of the corporation; and
…
The appellants’ case for breach of duty by Mr Weerappah extended beyond s 181(1)(a) of the Act. They also alleged contraventions of s 182 of the Act. Section 182 prohibits certain conduct involving the improper use of position. The relevant part of that section provides,
(1)A director, secretary, other officer or employee of a corporation must not improperly use their position to:
(a)gain an advantage for themselves or someone else; or
(b)cause detriment to the corporation.
His Honour did not seem to address that part of the appellant’s case involving an alleged improper use of position, save to find that the payment to Alamanda was ‘properly in discharge of Mernda’s obligations under the facility agreement and charge’. While initially raised as a ground of appeal, the appellants did not persist with a contention that the trial judge had erred in not addressing their case for contraventions of s 182 of the Act.
Having heard the evidence and submissions advanced on behalf of the appellants, the trial judge dismissed the proceeding. He said,[2]
12Identifying the individual interests of a company in a group of companies raises potentially troubled and problematic questions.[3] It may be accepted that in a group context each company is a separate and independent legal entity and that it is the duty of directors in such a case to consult the interests of each company and of its interests alone in deciding whether payment should be made to other companies.[4] In doing so, however, it will often be necessary to have regard to the fact that the interest of the individual company in question will be so intertwined with the interests of other members of the group that those interests cannot be ignored as part of the interests of the individual company and may need to be taken into consideration.[5]
13When Mernda entered into the facility agreement it had a contract of purchase to complete for which it needed a large amount of money that it did not have. It is misleading to say that by entering into the facility agreement it immediately became liable for debts of $10,141,125 because that amount was the total of the amount owing by all of the companies who entered into the facility agreement as borrowers and there is simply no foundation for the conclusion that the total liability would all be borne by Mernda in that amount at that time. Many of the companies had assets able to be realised at that time and the indirect benefits of a realisation of those assets may have exceeded the existing liability by an appreciable margin. The evidence before me makes it clear the other companies in the group all assumed the liabilities of each other and that others gave security for, in effect, the mutual benefit of the group through Alamanda. Indeed, the mechanism adopted by the facility agreement and charge may well have given greater security to the group through the advantage obtained by Alamanda as against third party creditors. Furthermore, the evidence of Mr Clements was that a calculation in December 2003 of the worst case scenario to Alamanda was of a shortfall of assets over liabilities of $3,750,000 and not $10,141,125. On any view it would be wrong to conclude that upon entering into the facility agreement Mernda was worse off by a net $10,141,125.
14I am not able to conclude that entering into the facility agreement, or the giving of the charge in support of or in addition to the facility agreement, was a breach by Mr Weerappah of his duties as a director. I am not able to accept that Mernda received an illusory benefit (as was contended) or had no interest in supporting the other 24 borrowers (as was also contended). Mernda needed to secure funds to complete its purchase and it needed to do so in the context of an arrangement between Mr Weerappah and Mr Robertson through which they conducted serial projects for profit. The facility agreement permitted Mernda at least to borrow the difference between the then extent of overall borrowing and the $15,000,000 cap which was calculated to be $3,828,359. As at that date it still needed to secure some $3,000,000 to complete its purchase. As at that date it did not have a contract of sale sufficient to cover any part of the amount it needed for it to complete its purchase. The facility agreement and the charge had the effect of internally cross collateralising the internal borrowings within the group and of ensuring that the group (through Alamanda) had first call upon the funds within the group. These are substantial advantages which a prudent director could sensibly secure by entering into such transactions as the facility agreement and the charge.
15The claim of breach of duty in relation to what was described as the Alamanda acquisition depends upon and follows from my conclusion about entering into the facility agreement and the giving of the charge. The Alamanda acquisition, namely, the receipt of the balance payable to Mernda upon settlement of its contract of sale of the property, was properly in discharge of Mernda’s obligations under the facility agreement and the charge.[6]
[2][2010] VSC 132, [14] and [15].
[3]Robert Austin, Harold Ford and Ian Ramsay, Company Directors (Butterworths, 2005) 282-285.
[4]Walker v Wimborne (1976) 137 CLR 1, 7 (Mason J).
[5]See, for example, Ashwick (Qld) No 127 Pty Ltd v Commissioner of Taxation [2009] FCA 1388 (Unreported, Ryan J, 26 November 2009).
[6]Emphasis added.
By their notice of appeal, the appellants contended, in summary, that the trial judge erred in finding that Mr Weerappah did not breach the duties he owed to Mernda under ss 181 and 182 of the Act; erred in finding that payment of the net proceeds of the settlement transaction to Alamanda was not a breach of duty; ought to have found that the facility agreement and charge were voidable; and ought to have found that the payment of the amount representing the GST collected from the purchaser of the land, was not an obligation under the facility agreement and caused Mernda to become insolvent.
The last ground summarised above formed part of a series of grounds reflecting the appellants’ pleaded case at trial relating to insolvent trading and payment of the GST amount. At the commencement of their appeal, the appellants abandoned so much of their appeal against the judgment as related to the alleged breach of duty by causing Mernda to pay the GST amount to Alamanda and to trade while insolvent, although the precise scope of the abandoned parts of the appeal was uncertain. The appellants said that they no longer pressed grounds of appeal 4, 5, 8 and 9. Ground 4 was concerned with the contention that the obligations of Mernda under the facility agreement did not extend to payment of the amount collected as GST. Ground 5 alleged that the trial judge ought to have found that the payment of the GST amount to Alamanda was in breach of ss 181 and 182 of the Act. Grounds 8 and 9 were concerned with insolvent trading in breach of s 588G(2) of the Act. There remained, however, grounds apparently pressed which relied upon the effect of the settlement transaction as causing Mernda’s insolvency, as the basis for impropriety in support of a breach of s 182 of the Act. The appellants’ position was finally clarified when, in the course of submissions, it became clear that the scope of the appeal was even more confined. The conduct of Mr Weerappah was to be examined only at the time he procured Mernda to enter into the facility agreement and grant the charge, and then only in terms of a breach of s 181(1)(a).
The appellants submitted that the appropriate test to be applied in determining whether Mr Weerappah had discharged his duty to Mernda under s 181(1)(a) of the Act was an objective test as formulated by Pennycuick J in Charterbridge Corporation Ltd v Lloyds Bank Ltd[7] where his Honour said:
Each company in a group is a separate legal entity and the directors of a particular company are not entitled to sacrifice the interest of that company. This becomes apparent when one considers the case where the particular company has separate creditors. The proper test, I think, in the absence of actual separate consideration, must be whether an intelligent and honest man in the position of a director of the company concerned, could, in the whole of the existing circumstances, have reasonably believed that the transactions were for the benefit of the company.
[7][1970] 1 Ch 62, 74.
While there has been some debate about the application of an objective test, and whether it is appropriate to consider whether in fact the directors considered the interests of the company, it is now generally accepted that an objective test ought to be applied.[8]
[8]Linton v Telnet Pty Ltd (1999) 30 ACSR 465, 472; Farrow Finance Co Ltd (in liq) v Farrow Properties Pty Ltd (in liq) (1997) 26 ACSR 544, 581 (Hansen J, Supreme Court of Victoria); Equitycorp Finance Ltd (in Liq) v Bank of New Zealand (1993) 32 NSWLR 50; 11 ACLC 952, 1019.
The appellants accept that the trial judge applied an objective test, but contend that he misdirected himself by proceeding on the basis that Mernda was part of a group. They argued that the trial judge erred when he approached his analysis on the basis that the relationship between the lender and the borrowers under the facility agreement was such that it was open to consider whether it may be in the interests of one member to support another or others or to ensure the success of a group as a whole. That was the context in which Pennycuick J made his observations in Charterbridge, and the context in which Mason J said, in Walker v Wimborne:[9]
To speak of the companies as being members of a group is something of a misnomer which may well have led his Honour into error. The word “group” is generally applied to a number of companies which are associated by common or interlocking shareholdings, allied to unified control or capacity to control. In such a case the payment of money by company A to company B to enable company B to carry on its business may have derivative benefits for company A as a shareholder in company B if that company is enabled to trade profitably or realize its assets to advantage. Even so, the transaction is one which must be viewed from the standpoint of company A and judged according to the criterion of the interests of that company.
[9][1975-1976] 137 CLR 1, 6.
The appellants submitted that the concept of a group, involving intertwined interests, unity of control, mutual benefit or shared objectives was wholly inconsistent with the way in which Messrs Robertson and Weerappah conducted their joint venture. They submitted that it was an essential component of their modus operandi to quarantine each project and entity from the influence, positive or negative, of another. Thus, they argued, while there was common control, it was no part of the business of any one development entity, and thus borrower, to support the position of another.
The appellants’ contention that the trial judge erred in holding that Mernda was a member of a group of companies was no doubt based on a perception that such a characterisation was a crucial stepping stone in his Honour’s reasoning process. We are not persuaded that his Honour’s description of the parties to the agreement as a group was necessarily incorrect. In our opinion, Mernda was part of a group of companies. His Honour looked beyond the mere label, to the nature of the relationship between the parties, but having done so, reached an incorrect conclusion.
The proper starting point for the inquiry to ascertain whether Mernda’s entry into the facility agreement, and its granting of the charge were in its best interests, was to consider the consequence to Mernda from its entry into the facility agreement. Only then could an analysis of the relationship between the parties have meaning, and inform the ultimate question – whether an intelligent and honest person in the position of Mr Weerappah could, in the whole of the existing circumstances, have reasonably believed that the transaction was for the benefit of Mernda.
His Honour said that the evidence made it clear that the other borrowers all assumed the liabilities of each other. That much is clear. He went on to conclude that such an arrangement gave security for, in effect, the mutual benefit of the group through Alamanda. He found that the facility agreement and charge may well have given greater security to the group through the advantage obtained by Alamanda as against third party creditors. While it is not entirely clear what his Honour meant by ‘greater security to the group through the advantage obtained by Alamanda as against third party creditors’, it may suggest that one object or effect of the facility agreement was to protect each borrower from claims by creditors. This would be achieved by conferring on Alamanda the ability to strip the companies of their assets as a secured creditor.
The appellants did not argue at trial that the breach of duty that occurred involved a breach of the duty owed to the company to protect its creditors. That duty has been characterised as one owed to the company as a corporate entity rather than as a whole, meaning the members. Such a duty may become enlivened when a company is insolvent or nearing insolvency, where the creditors are seen to have a direct interest in the company that cannot be overridden by the shareholders.[10] On appeal, the appellants disavowed any such contention.
[10]See Sycotex Pty Ltd v Basler (1994) 122 ALR 531; 13 ACSR 766, 785 ( Gummow J).
The trial judge did not accept that Mernda received an illusory benefit, or had no interest in supporting the other borrowers. He found that Mernda needed to secure further funds to complete its purchase, and that the facility agreement permitted it to at least borrow the difference between the then extent of the overall borrowing and the $15 million cap which was calculated to be $3,828,359.
It was, of course, possible that the total borrowings might rise or fall, depending on the needs of other borrowers or the realisation of their assets. Mernda had obligations under a contract that required it to pay $850,000 on 1 September 2003 and the balance (approximately $7.5 million including GST) on 1 September 2004. His Honour concluded that the mutual support, cross-collateralisation and the limited opportunity to borrow were substantial advantages which a prudent director could sensibly secure for Mernda by procuring it to enter into the facility agreement and give the charge.
In our opinion, the terms of the facility agreement and the relationship between the parties to the facility agreement – the members of the group - contradict these findings. Of particular importance is cl 2.2.2 which did not give to Mernda, or any other borrower for that matter, any entitlement to draw down further advances. The appellants had drawn attention to that provision at trial. Thus, it was not correct to conclude, as did the trial judge, that the facility agreement permitted Mernda at least to borrow the difference between the then extent of overall borrowing and the $15,000,000 cap which was calculated to be $3,828,359. Mernda had no such entitlement.
A further important feature of the facility agreement, which did not seem to be mentioned at trial, was the repayment date of 31 December 2003. Each borrower was liable to repay its indebtedness (and, to the extent to which others may not be able to do so, meet the obligations of the others) a little over six months from the date of entering into the facility agreement. That was, in the case of Mernda, before it would have been required to complete its purchase of the land.
A further, and in our view critical, provision is cl 3.1.1, which required any borrower who sold or disposed of any real property or any interest in real property, to pay the whole of the proceeds to the lender, up to the amount of the principal advanced at the time, whether or not the borrower was indebted for that amount. The effect of that provision became apparent in the settlement transaction on 19 December 2003 (before the repayment date for the principal) when Mernda was required to pay the whole of the net amount received to the solicitors for Alamanda.
The time at which the analysis is to be undertaken of compliance with the duty imposed under s 181(1)(a) of the Act, is the time at which the directors procured Mernda to enter into the facility agreement and give the charge. The appellants did not press their contention, apparently advanced at trial, that the settlement transaction involved a breach of duty. They confined their case to the conduct of the directors in procuring Mernda to enter into the facility agreement and to give the charge. But even so, the terms of the agreement and charge, requiring Mernda to disgorge the whole of its assets, up to the amount of the Principal advanced was, to say the very least, most unusual. It is difficult to conceive of a basis upon which an intelligent and honest person, in the position of Mr Weerappah (and for that matter Mr Robertson) could, in the whole of the existing circumstances, have reasonably believed that it was for the benefit of Mernda to incur a liability for the debts of the other borrowers, payable on 31 December 2003, coupled with an obligation to disgorge all proceeds on disposal of its asset in circumstances where it was not entitled to any further advances.
On that basis alone, Mr Weerappah breached his duty to Mernda under s 181(1)(a) of the Act by procuring Mernda to enter into the facility agreement and give the charge. The relationship between the borrowers is another factor which supports such a finding. The business of each of the borrowers was to be quarantined from the risks associated with each other project. By entering into the facility agreement, they became exposed to an incompatible risk of immediate liability for the debts of others. Furthermore, while the events surrounding the settlement transaction were no longer relied upon to establish a breach of duty, the effect of the facility agreement, as noted by the trial judge – to give greater security as against third party creditors – may of itself evidence a breach of duty to the company to protect its creditors.
The appellants, in their statement of claim, claimed that Mernda was entitled to rescind their facility agreement and charge and elected to do so. They claim the return to Mernda of the net amount paid on 19 December 2003 less the indebtedness of Mernda to Alamanda. The net amount claimed from Alamanda by way of restitution is $7,724,289.46.
There is little doubt that if a transaction, such as that recorded in the facility agreement and charge, was procured by a director in breach of a fiduciary or analogous statutory duty, the transaction may be voidable at the instance of the company. Affirmation, delay, intervention of third party rights and inability to give counter-restitution may cause any right to rescission to be lost.[11] In Robins v Incentive Dynamics Pty Ltd, Mason P, in the New South Wales Court of Appeal[12] said,
[74]In some situations, an order for rescission will be at least a practical necessity (Greater Pacific at 153). If such an order is sought independently or as a step towards a remedial constructive trust based upon the process of tracing the "trust" money into the hands of the recipient or into the property acquired by the recipient with that money, the remedy is discretionary. In general, the court will need to be satisfied that a remedial constructive trust (or charge if that suffices) is necessary to protect the legitimate rights of the plaintiff and does no injustice to the rights of third parties, such as creditors (see Daly v Sydney Stock Exchange Ltd (1986) 160 CLR 371; Australian Securities Commission v Melbourne Asset Management Nominees (receiver and manager appointed) (1994) 49 FCR 334 at 358-359; Giumelli v Giumelli (1999) 196 CLR 101 at 113-114).
[75]A full proprietary remedy is not always necessary or appropriate and it is not automatic. Sometimes the interests of innocent third parties such as creditors will mean that the plaintiff will be confined to a personal remedy or the narrower remedial constructive charge. But a remedial constructive trust will generally be appropriate where profit can be traced into identifiable property in the hands of the defaulting beneficiary or the agent of the defaulting beneficiary (see generally RP Meagher, JD Heydon and M Leeming, Meagher, Gummow & Lehane's Equity Doctrines and Remedies 4th ed at [5-250]).
[11]Robins and ors v Incentive Dynamics Pty Ltd (in liq) and anor (2003) NSWCA 71; 45 ACSR 244, [73].
[12]With whom Stein and Giles JJA agreed.
This court was not informed of the likely impact of any remedy on creditors and other third parties. Any order against Alamanda requires court approval before it may be enforced. In the circumstances, we do not consider a remedial constructive trust as an appropriate remedy and would confine Mernda’s claim for recovery of funds to a personal remedy against Alamanda for the amount claimed.
Section 1317H of the Act authorises a court to order a person to compensate a corporation for damage suffered as a result of a contravention of s 181(1)(a). Having found that Mr Weerappah breached his duty to Mernda under s 181(1)(a), it is appropriate that an order for compensation be made against him for the loss sustained by Mernda resulting from the contravention. But for Mernda’s entry into the facility agreement, and its giving of the charge, it could not have been lawfully compelled to pay the whole of the net proceeds from the settlement transaction to Russell Kennedy on 19 December 2003. The payment was expressly made pursuant to the obligations under the facility agreement and charge. That being so, the amount of compensation payable should be the amount of the payment less the amount then owing by Mernda to Alamanda. No claim has been made for compensation in the nature of interest from the date of payment until the commencement of the proceeding.
Leave to proceed
In the course of communications between the appellants and Alamanda concerning an application by the appellants to reinstate the appeal, the solicitors for Alamanda asserted that leave to proceed under s 500(2) of the Act was required for the appeal.
On 23 July 2009, Mernda and its liquidator made application for leave to continue the proceeding against Alamanda under s 500(2) of the Act. The liquidator of Alamanda notified the appellants that they did not oppose the leave application which was to be heard on 7 August 2009. On that day an associate judge of this court granted leave, nunc pro tunc, for the plaintiffs to proceed against Alamanda. The grant of leave was made on the usual undertaking given by the liquidator of Mernda that he would not attempt to enforce any judgment or other order obtained against Alamanda without further leave of the court.
Prompted by the first respondent, who did not attend the appeal, the appellants have raised the question as to whether a further grant of leave is necessary to prosecute this appeal and, if so, they seek leave nunc pro tunc. They submitted that several Australian courts had considered whether leave was required on appeal in cases where the appellant had already been granted leave at first instance. In a detailed written submission, the appellants reviewed authorities extending back to Humber & Co v John Griffiths Cycle Company.[13] Most of the cases were concerned with the question whether there was a requirement for leave prior to or in the course of an appeal, when no leave had already been granted. Those cases are plainly distinguishable. In the present case leave to proceed was granted prior to the first trial. In Moore v Scolaro’s Concrete Constructions Pty Ltd,[14] the defendant had gone into liquidation during the course of proceedings at first instance. The plaintiff had sought and was granted leave under s 471B of the Act. On appeal from the judgment below, the Court of Appeal granted leave, nunc pro tunc, ‘to regularise the appeals if necessary’.
[13](1901) 85 LT 141.
[14][2004] VSCA 152.
The appellants submitted that the authorities do not establish the proposition that once leave has been granted at trial it must be refreshed in relation to an appeal. Those cases which concern appeals brought by an insolvent appellant, or which are defensive in nature, seem to have no application to the present facts.
We are inclined to the view that leave already having been granted prior to trial, a further grant of leave is not required. The absence of a contradictor makes this an inappropriate vehicle to resolve the question, insofar as there may be any doubt about that proposition. For present purposes, and out of an abundance of caution, it is enough that the approach adopted by this court in Moore v Scolaro’s Concrete Constructions be followed. Accordingly, we would grant leave to proceed against Alamanda, insofar as it is necessary, on condition that any judgment against it will not be enforced without the further leave of the court.
Orders
We would allow the appeal and make the following declaration and orders:
(1)Pursuant to s 500(2) of the Corporations Act 2001 (Cth) the appellants have leave to proceed with their appeal nunc pro tunc against the first respondent, insofar as leave is necessary, on condition that any judgment against it will not be enforced without further leave of a Judge.
(2)The appeal is allowed.
(3)The orders of Pagone J made 19 April 2010 are set aside and in lieu thereof the following orders are made:
(i)A declaration that the Facility Agreement dated 15 May 2003, and the charge granted by the first plaintiff dated 8 July 2003, are both void as against the first plaintiff.
(ii)An order that the first defendant repay to the first plaintiff the sum of $7,724,289.46.
(iii)An order pursuant to s 1317H(1) of the Act that the second defendant pay compensation to the first plaintiff in the sum of $7,724,289.46.
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